EC120: The World Economy in Historical Perspective

1. EC120: The World Economy in Historical Perspective Topics: Bretton Woods - A New (and Short-Lived) International Monetary Order 1. Planning for the Post-War, While Avoiding the Mistakes of the Past 2. The Key Elements 3. The First (Unsuccessful) Attempt to Resume Current Account Convertibility: Britain, 1947. 4. Current Account Convertibility Postponed: The Marshall Plan and the EPU. 5. Current Account Convertibility (sort of) Achieved (at least in Europe), 1959. 6. Signs of Strain Appeared Almost Immediately Thereafter. 7. Progressive Breakdown in the 1960s, Collapse 1971-73. 8. By Default, A New Regime of Floating Rates 9. The European Response: The Start on the Long Road to the Euro. EC120 2014 Week 22, topic 17, slide 0

2. EC120: The World Economy in Historical Perspective Planning for the Post-War, While Avoiding the Mistakes of the Past What to restore: the goal was to return to something like the pre- 1914 multi-lateral fixed exchange-rate regime that had once been so conducive to trade and prosperity. What to avoid: the deflationary bias, the potentially destabilizing “hot money” flows, the competitive devaluations, and the extreme trade barriers of the inter-war years. EC120 2014 Week 22, topic 17, slide 1

3. EC120: The World Economy in Historical Perspective • 1a. Preparations for the Conference at Bretton Woods • • The first tentative steps: The Atlantic Charter, August 1941. • • Detailed planning began in earnest in 1942 (the programme was not an over-night wonder). • • Since the time and the circumstances of the end of the war were not known in August 1944, flexibility was unavoidable and emerged as a key characteristic of the Bretton Woods System. • ̶ Political origins (place and timing). • Churchill and Roosevelt aboard HMS Prince of Wales, August 1941 H.D. White J.M. Keynes

4. EC120: The World Economy in Historical Perspective 2. The Key Elements of Bretton Woods. The three key innovations: “Par values” would be set, thus fixing exchange rates, but with arrangements to make them adjustable (by agreement, supervised by the IMF), thereby making the occasional, inevitable currency realignments less disruptive. • The acceptance of controls, at least temporarily, particularly on capital flows, but also on trade and foreign exchange transactions generally, thereby creating an additional policy tool intended to ease (or defer) balance of payments adjustments. The creation of new international institutions each intended to enhance a specific aspect of international economic co-ordination (e.g. IMF (exchange rate adjustments), IBRD (capital flows), and the ITO (trade), the latter of which was in fact deferred until 1996, when the WTO was established, superseding the ‘interim’ non-institutional GATT). EC120 2014 Week 22, topic 17, slide 3

5. EC120: The World Economy in Historical Perspective The First (Unsuccessful) Attempt to Resume Current Account Convertibility: Britain, 1947. American hopes for a fixed-exchange rate, multilateral trading order. Britain, the strongest of the European economies in the immediate post-war period, was the obvious candidate to lead the European return to at least current account convertibility. The Imperial bonus. British Factory 1947 EC120 2014 Week 22, topic 17, slide 4

6. EC120: The World Economy in Historical Perspective 3a. Obstacles to British Current Account Convertibility ● Britain’s monetary overhang: the overseas sterling balances, especially in India and Egypt. ● The slow growth of British exports, due not least to exchange and trade controls in western Europe, which caused Britain to accumulate “soft” (inconvertible) currencies, while running deficits with “hard” currency areas. ● British desire (not least in the private sector) to rebuild stocks of foreign assets • At $4.03, an exchange rate that was almost certainly over-valued after 1945. ● Convertibility commenced 15 July 1947; it ended in disaster 20 August 1947, adding urgency to the establishment of the Marshall Plan.

7. EC120: The World Economy in Historical Perspective 4. Current Account Convertibility (and the rest of Bretton Woods) Postponed: The Marshall Plan (commencing April 1948) and the EPU (commencing July 1950). • The British disaster ended any hope of a near-term return to convertibility in Europe and drove home the need for more financial and trade assistance to achieve European recovery. • Aid was forthcoming in 1948 (the Marshall Plan), but only after suspending key elements of the Bretton Woods’ agreements. The U.S. accepted that barriers against its exports would be dismantled more slowly than barriers to intra-European trade, putting in abeyance the quest for non-discrimination in international trade (restoration of “most favoured nation” clauses). The roles of the IMF and IBRD in European reconstruction were greatly reduced to prevent “double-dipping” . The EPU further formalized these departures from the intended norm. EC120 2014 Week 22, topic 17, slide 6

8. EC120: The World Economy in Historical Perspective • Current Account Convertibility (sort of) Achieved (At Least in Europe), 1959. • ● The EPU was “hardened” in 1954 and 1955, before being wound up in December 1958, at which time the major European currencies became convertible for trading purposes (but not for investment). Nominal capital controls remained. • ● Discrimination against American imports was relaxed and renewed efforts to reduce trade barriers more widely were made. • Frankfurt, c.1959

9. EC120: The World Economy in Historical Perspective • Signs of Strain Appeared Almost Immediately Thereafter. ● The dollar shortage was changing into a dollar glut. (For how and why, see Bordo (1993) Figs. 1.10, 1.11, 1.12, and 1.18). ● An early (but ultimately inadequate) response to growing strains (i.e. when the open market price of gold rose above $35.20/oz.): the London Gold Pool, November 1961, and central bank swap lines, March 1962, both established to support the dollar price of gold. ● Growing capital market sophistication (for example, over-invoicing imports while under-invoicing exports) rendered unworkable short-terms fixes for the dollar and the “adjustable peg” for other currencies; markets refused to wait for politicians and policy- makers. ● A structural problem: how could international reserves be increased fast enough to keep pace with the extraordinary growth in trade? See Bordo (1993), Fig.1.15 for an indication of relative magnitudes.

10. EC120: The World Economy in Historical Perspective 6a. The vexed, persistent question of who should adjust and how? ● The inadequacy of limited revaluations by countries with strong balance of payments (notably West Germany), especially as capital controls became less effective as trade restrictions were relaxed after 1958. ● The political economy of adjustment. • American refusal to play by ‘the rules of the game’ and curb its growing payments deficit by restrictive monetary and fiscal policies. • British resistance to the policy tightening needed to defend sterling. • The reluctance of the West German government to ‘penalize’ successful exporters. • French resentment at America’s ‘exorbitant privilege’, followed by dollar liquidation from French foreign exchange reserves. • Tensions over Franco-German currency realignments, August-October 1969 led to a French devaluation of 11.1% in August and a German revaluation of 9.3% in October (after elections in September).

11. EC120: The World Economy in Historical Perspective Progressive Breakdown in the 1960s, Collapse 1971-73. • European strains: British devaluation, November 1967; French devaluation, August 1969. (See Baldwin & Wyplosz (2004), Fig. 10-4.) • Nixon closed the ‘gold window’ at the Fed, August 1971, ending any pretence of the gold convertibility of the dollar. Import ‘surcharges’ (effectively tariff increases) were also introduced. Continued American budget deficits, joined by the growing budget deficits of other governments led to the complete collapse of the Bretton Woods regime in March 1973, with the dollar continuing to fall. The first ‘oil shock’ occurred in October of that year. John Connolly, US Secretary of the Treasury 15 August 1971 EC120 2014 Week 22, topic 17, slide 10

12. EC120: The World Economy in Historical Perspective By Default, A New Regime of Floating Rates Emerged in 1973 After floating, the dollar initially fell against most currencies, but not uniformly. Subsequent movements were determined largely by variations in expected inflation not compensated by higher interest rates, with the currencies of more rapidly inflating economies tending to fall. (See Baldwin & Wyplosz (2004), Fig. 10-4). Small, open advanced economies, most of them in Europe, were most at risk of trade disruption in the new order. EC120 2014 Week 22, topic 17, slide 11

13. EC120: The World Economy in Historical Perspective The European Response: The Beginning of the Long Road to the Euro. The end of Bretton Woods marked the end of the attempt to recreate a global system of fixed exchange rates, but not the end of attempts to peg exchange rates among close trading partners in Europe. From “Snake” to monetary union in Europe: the early travails of a Europe’s regional version of the Bretton Woods System and the growing belief that only comprehensive monetary union could ease them. (See Eichengreen (2008), Table 5.1) Pierre Werner, Prime Minister of Luxembourg, whose report on European monetary union was delivered in October, 1970 EC120 2014 Week 22, topic 17, slide 12